Australia | Sep 10 2019
Australia's retail sector is at a low ebb. An eagerly-awaited improvement is expected to emerge over the next 6-12 months and brokers assess which stocks may benefit.
-Subdued reporting season set aside in favour of improved outlook
-Online trajectory expected to outpace total sales growth for a number of years
-PE multiples re-rated as earnings downgrades were widespread
By Eva Brocklehurst
Multiple challenges exist for Australia's retail sector amid low levels of housing turnover, little income growth and an unemployment rate that is forecast to remain above 5% for at least the next year or so.
Most of any improvement is expected to come over the next few months from income tax rebates and lower interest rates, supporting disposable incomes. However, Macquarie suggests risks remain and a false sense of security may be emerging about the outlook for the Australian economy.
The broker acknowledges some signs that consumer circumstances are improving, although this is emerging from a very low ebb as the earnings performance of the listed consumer sector was one of the worst on record during the latest reporting season.
UBS found the results season polarising. Discretionary retail outperformed, with the market appearing to look through softer second half trends as the outlook was better. Staples were broadly in line with expectations while the food/beverage sector was disappointing.
Moreover, most retailers have reported positive like-for-like sales growth in FY20 to date, although, as yet, no retailer has called out tax cuts as a driver. Nevertheless, the broker expects tax cuts will provide improved retail sales growth over the next 6-12 months, and assuming around 50% of this is spent it would drive around one percentage points of retail sales growth.
UBS notes of the 14 retailers that reported, only five recorded an improvement in second half earnings (EBIT) growth versus the first half. The main disappointments were Harvey Norman ((HVN)) and Inghams Group ((ING)). UBS still assumes conditions will improve in FY20 for Harvey Norman.
Given improving housing conditions and a positive impact from tax rebates, Morgans expects updates at retailer AGMs will provide the next catalyst for the sector. The best potential, in the broker's view, relative to current expectations, lies with Accent Group ((AX1)), Beacon Lighting ((BLX)), Super Retail ((SUL)) and Michael Hill ((MHJ)). Macquarie agrees there has been some signs of better consumer activity at Beacon Lighting, Adairs ((ADH)) and Super Retail.
At the results, nearly every retailer pointed to the persistence of strong online sales growth, while foot traffic was soft. The vast majority of like-for-like sales growth continues to be supported by online penetration, brokers note. Hence, online sales growth is expected to outpace total sales growth for years to come.
The highest level of online penetration rates, Morgans points out, were with Domino's Pizza ((DMP)), Adairs, Accent and Baby Bunting ((BBN)). UBS also notes the largest contributors to overall online growth in retail were Rebel Sport & Supercheap Auto (Super Retail) and Adairs.
Morgans also found gross margins among the consumer sector were more resilient, which suggests price increases are being passed through and/or competitor activity is contained. The worst performing segment of consumer discretionary stocks was automotive sales, because of high unit prices, the link to housing and the very discretionary nature of the product.
Over 2019 to date, the consumer sector has outperformed the market and Macquarie attributes this to a hefty re-rating of PE (price/earnings) multiples as earnings downgrades persisted. Nevertheless, the broker does not find the sector cheap and, while finding better value in discretionary retail versus staples, does not consider valuation is a driver.
Against this backdrop, Macquarie retains a preference for Coles ((COL)) over Woolworths ((WOW)) in staples and considers both Domino's Pizza and Treasury Wine Estates ((TWE)) have multi-year growth stories that offer offshore exposure at fair multiples.
Downgrades to earnings projections were widespread in the results, Macquarie points out, with only JB Hi-Fi ((JBH)) being meaningfully upgraded. JB Hi-Fi and Harvey Norman are considered too expensive and, the broker observes, operating leverage continues to slow.
Citi revamps its pecking order following reporting season, moving Michael Hill to number one, assessing the stock is trading at an undemanding 6x FY20 earnings per share. Beacon Lighting has also risen in the order, upgraded to Buy, while Lovisa Holdings ((LOV)) moves down to number six from number one, as currency headwinds and ongoing investment in new markets are likely to constrain short-term growth.
During reporting season UBS upgraded Super Retail, Myer ((MYR)) and Domino's Pizza to Buy and downgraded JB Hi-Fi to Sell. Upside risk is envisaged from Viva Energy ((VEA)), Domino's Pizza and a2 Milk ((A2M)), as the market appears to have taken a relatively pessimistic view on these stocks post the results.
Downside risks exist for JB Hi-Fi, Flight Centre ((FLT)), Kogan.com ((KGN)), Super Retail and Costa Group ((CGC)) as, UBS asserts, these have had share price movements which are more positive that their results warranted.
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